East Asian societies face an interesting paradox: while people and firms often rely on personal connections or private relations to conduct businesses or deal with government, many loathe such clandestine affairs that brew corruption and long for an opportunity to establish fair and efficient public rules. However, when the opportunity does come, such as the democratization in Taiwan and South Korea or the reforms in China, people tend to go overboard by creating too many rules that are sometimes onerous and stifling, so that the new rules suffocate people, businesses, and government instead of improving efficiency as expected .

Such a paradox is rooted in the evolution of the governance environment in East Asian societies. Governance is a mechanism to protect individual and business interests in social and economic exchanges, such as legal or private means to enforce contracts and rewards – or punishments when someone breaches them. The governance environment is a set of social, political, and economic institutions, i.e., laws, regulations, or culture, which facilitates or constrains the functioning of governance mechanisms which individuals and firms apply within a society. In a society of efficient and fair governance, e.g., one where there is the rule of law, people turn to public governance when their personal interests are offended. However, if people perceive public laws to be biased or corrupt, they have little trust in the judiciary system and turn to private recourses to resolve disputes. In general, most societies evolve from relation-based to rule-based governance as they mature over time.

Each type of governance has its own advantages depending on the stage of social development. Rule-based governance incurs a huge set-up cost to establish legal infrastructure, i.e., well-balanced branches of the government and training legal professionals. Once the infrastructure is built, the incremental cost of enforcing additional contracts is minimal. On the contrary, relation-based governance places contractual enforcement into private hands, which does not require a significant fixed cost. This can be efficient when transactions remain within a small scale economy, such as a village where everybody has close connections with each other. When the economy expands, however, the cost of enforcing relation-based transactions increases rapidly since it involves strangers who are difficult to govern with private connections.

Another key factor that sets apart the two governance modes is public trust. The society must have a high level of public trust for the rule-based system to work efficiently. Public trust is the faith and confidence one has in a complete stranger within a society. Political scientists believe that public trust is a fundamental building block of a mature democracy , which is an advanced form of rule-based governance. Public trust reduces the monitoring costs in socioeconomic exchanges such as verifying the authenticity of a university diploma before hiring or, visiting the physical address of a company before buying its stock. In relation-based societies, due to the lack of public order and the reliance on one’s family and close friends for governance, people do not trust strangers. These societies have developed a strong culture of personal loyalty based on reward for honoring it and harsh punishment for betraying it. While some in East Asia may call it “trust”, it is the opposite of the public trust we described above.

As East Asian economies expand fast and begin to move away from relation-based governance and toward public rules, they face the governance dilemma of adopting too many rules that may stifle efficient social transactions. The transformation of governance is met with great enthusiasm by the populous because officials’ abuse of power tends to be rampant and only a small group of individuals and companies enjoy privileges through cozy relations with the powerful. After a long history of suffering from abuse and unfairness, East Asian societies have seized an opportunity to make stringent rules to limit officials’ discretion of power and establish fair and reliable governance.

The overreliance on public and organizational rules and regulations is common in all sectors of East Asian societies. The college admission system is a good example. In a well-developed rule-based society, e.g., the U.S., the admission decision considers recommendations by teachers and school counselors, test scores, personal statements, high school grades, and self-reported activities. In East Asia, college admission relies heavily on the entrance examination. Why? If recommendations were allowed, people would use personal connections to get good evaluations from powerful people. In 2009, leading universities in China initiated a new recommendation-based policy in lieu of the traditional examination to reflect students’ overall character in admission decisions. However, the public became heavily critical of the new policy as they doubted the integrity and credibility of recommendations. Universities eventually succumbed to public perception and decided to drop the well-intended policy as of March 2015. What about evaluating university professors’ research? Since there is little faith in administrators’ or colleagues’ evaluation of others’ research, universities rely exclusively on standardized journal lists, such as FT list or SSCI journals, based on certain citation indices to reward, promote, or punish professors. There are generally more checks and scrutiny along the organizational hierarchy. The lack of trust in people and overreliance on rules and procedures result in a heavy toll on efficiency and effectiveness , while suffocating talented individuals and their input on governance. East Asian societies have become a giant battlefield of examinations: there are examinations for kindergarten, elementary school, middle and high school, college, jobs, and promotions. The examination-only teacher-hiring-system selects a group of high IQ-test performers who are not necessarily capable teachers. Colleges are full of test-taking wiz-kids with little creativity. Professors game the indexed journal list by publishing in some that are relatively easy to get into even if they are not in one’s own field.

East Asian societies still go through fast and unpredictable changes in economic systems, institutions, and consumer behavior, which require speed and flexibility in organizational operations. However, due to the lack of public trust, they are trapped with overreliance on rules and regulations as relation-based governance transforms into rule-based governance. This is a serious governance dilemma the societies have to deal with. Relying on rigid rules deters smooth transition to an efficient and effective rule-based system. Instead of rushing to set up more rules and regulations, governments, societies, and organizations in East Asia need to nurture public trust. As Kenneth Arrow, a Nobel laureate in economics, said, “Virtually every commercial transaction has within itself an element of trust." Good rules cannot function well without basic trust.

Seung Ho Park is Parkland Chair Professor of Strategy at CEIBS, Shaomin Li is Eminent Scholar and Professor of International Business at Old Dominion University Strome College of Business, and Kuang S. Yeh is Professor at the National Sun Yat-sen University.